Do Stock Market Trading Activities Forecast Recessions?
Ujjal Chatterjee (U. of Wisconsin-Milwaukee, American University of Sharjah)
August 9, 2016
This paper re-examines the existing recession forecasting models with stock market liquidity as an additional forecasting variable. We investigate three distinct aspects of stock market trading activities, namely stock market liquidity, returns and volatility as predictors of U.S. recessions. We also conduct a horse race comparison in the recession forecasting power between various stock market liquidity measures. We show that i) lower stock market liquidity signals recessions; ii) stock market liquidity and returns forecasts recessions up to three into the future, while stock market volatility has no forecasting power; iii) stock market liquidity as computed by stock transaction costs and by stock price changes to trading volume forecast recessions better than other measures in the literature; iv) stock market liquidity-based models outperform the survey of professional forecasters’ estimates of recession probabilities, and hence the results suggest that professional forecasters may need to incorporate stock market liquidity in their forecasts. The results have potential preemptive monetary policy implications.
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US economic growth continues to rebound after a soft patch in the first half of the year. Supported by stronger job growth in June and July, the firmer trend in the actual data follows projections published by The US Business Cycle Risk Report and The Capital Spectator in previous months for a revival in the pace of the expansion (see the bottom charts here and here, for example). The recovery is expected to strengthen in the months ahead, as summarized in today’s update, as shown in the last chart at the bottom of this post.
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Economic output in the US is on track to rebound sharply in the third quarter, according to several estimates. Some analysts are looking for growth in excess of 3% when the Bureau of Economic Analysis publishes the “advance” Q3 report on Oct. 28. Even the cautious forecasts are generally anticipating a solid bounce of 2%-plus, which represents a healthy improvement over Q2’s sluggish 1.2% increase (seasonally adjusted annual rate).
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Fed fund futures continue to imply a low probability of a rate hike at next month’s FOMC meeting, but the annual trend in real (inflation-adjusted) base money supply points to a slightly firmer bias for anticipating another round of monetary policy tightening in the near-term future.
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US economic growth strengthened for the second month in a row in July, according to this morning’s update of the three-month average of the Chicago Fed National Activity Index (CFNAI-MA3). Last month’s reading ticked up to -0.10, the highest level since February. Today’s update effectively confirms that the recession risk remained low last month.
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Commodities rebounded sharply last week, posting the strongest gain among the major asset classes, based on a set of representative exchange-traded products. The rise marks the second weekly increase for broadly defined commodities.
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The Capital Spectator will be on furlough for the rest of the week, focusing on recreational R&D in an undisclosed location. The standard routine resumes on Monday, Aug. 22. Cheers!

The relatively obscure corner of foreign inflation-linked government bonds edged out the rest of the field last week with 2.1% total return, based on a set of proxy ETFs for the major asset classes. The performance was just enough to fractionally pull ahead of foreign stocks in developed markets, the number-two performer for the five trading days through Aug. 12.
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● Inside the Investments of Warren Buffett: Twenty Cases
By Yefei Lu
Summary via publisher (Columbia University Press)
Since the 1950s, Warren Buffett and his partners have backed some of the twentieth century’s most profitable, trendsetting companies. But how did they know they were making the right investments? What did Buffet and his partners look for in an up-and-coming company, and how can others replicate their approach? A gift to Buffett followers who have long sought a pattern to the investor’s success, Inside the Investments of Warren Buffett presents the most detailed analysis to date of Buffet’s long-term investment portfolio.
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Consumer spending in the US was flat in July, the Commerce Department reports. The surprisingly weak month may be payback for the strong gain in June, which surged 0.8% in today’s revised data. Meanwhile, the year-over-year trend in headline retail ticked lower. Putting it all together suggests that the appetite for consumption is still positive, but the growth rate is easing. Is that a concern? Maybe, although the recent revival in the pace of job creation implies that retail sales will continue to post steady if unspectacular growth.
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